BEM
103: Introduction to Finance
J-L
Rosenthal
Lectures
MW 8:30 10 Kerkoff 119
NOTE From WEDNESDAY
October 9. Class will begin at 8:30 AM
Ta
Sections
There are now three section.
Tatiana Mayskaya’s section is 9-10 Am Friday in Baxter 127
Li Song’s section is 10-11am Friday in Baxter 125.
Jean-Laurent Rosenthal section is 11-12am Friday in Baxter 128.
Tatiana and Li will do all the grading.
Note: TAs are not available for
Email consultation (this is the instructor’s decision), you can make
appointments to see your TA but this is not 24/7 service.
Contact: jlr@hss.caltech.edu
Class web site:
http://www.hss.caltech.edu/~jlr/courses/BEM103/BEM103Syllabus.htm
Office
hours: Thursday 10:30-12 Baxter
133
Goals of the Class: This class introduces key concepts and issues in finance. To do so we will learn some of the basic (but fully relevant models) behind asset pricing and investment evaluation. We will also learn about the organizations and institutions that structure financial transactions in the US and elsewhere. Finally we will bring the theory and the rules of the game to examine important events and ongoing trends in finance today.
Text books: The class relies, mostly on opens source material, so there is no required text book. The relevant background material will be posted on line. You should however purchase Arnold Glen’s Financial Times Guide to the Financial Markets (FT Press 2012. $25.49) as it is a critical guide to institutions and basic facts.
Student responsibilities
Home work: There will be weekly homework sets. These will be of moderate length and not graded. You are welcome to do these homework sets as team. To ensure you attend class and engage the homework, there will be 9 in class quizzes based on the previous week’s homework and in class material.
Finance journal: You are asked to hold a finance journal in electronic form. This will involve making stock/bond picks and following their returns. Doing so will allow you to evaluate your decisions relative to the financial models we choose. The updated version of the journals will be due by Friday at 1pm (close of market in NY) each week. Journals will be graded for completeness and extra credit will be given for journals that outperform the market. (More details at end of syllabus)
Examinations: There will be a mid-term (25 pt), a final (50pts), and 12 in class quizzes (4pts each). 27 pts will be given for a completed journal (because work is cumulative this does not break down into weekly returns). Thus 150 pts total are available, 50% guarantees an F. and every additional 10% an extra grade. 90% guarantees an A.
10 pts are available for extra credit. Journals will be ranked in terms of final asset performance by decile, your decile rank will decide you the number of extra credit points.
9-30. Class 1: From claims to value
Relevance of Class, Basic
material, The problem of value, Value
for investors, Market value and efficient markets (1) Why do different people
have different demands vs (2) No trade result.
Reading: JW1 and BO1 and Arnold CH 1. (note all of these are very brief and very easy)
10-02
Class 2: Value for Issuers
Acceleration and Evaluation of projects;
Capital budgeting; Modigliani Miller vs Risk and
taxes
The Original Paper: Franco Modigliani, Merton H. Miller “The Cost of Capital, Corporation Finance and the Theory of Investment “ The American Economic Review, Vol. 48, No. 3 (Jun., 1958), pp. 261-297.
10-07
Class 3: Exchange mechanisms
Secondary markets and the double auction;
Primary markets and underwriting; rapid changes in the structure of global
finance
Reading: Arnold Chapter
10-12
10-09
Class 4: Modern Finance?
Financial
axioms vs behavioral finance and imperfect markets;
Financial markets are competitive Value additivity;
No Free Lunch; Markets are efficient
Reading: BO2
10-14
Class 5: Asymmetric Information
The market for lemons and the winner’s curse. Efficient market Information aggregation
Reading:
Benmelech, Efraim, and Jennifer Dlugosz,
2009b, The Credit Rating
Crisis,
NBER Macroeconomics Annual 2009, 161-207.
10-16
Class 6: Pricing riskless Bonds
Net
Present value, again; Fed policy and inflation; Expectations and the yield
curve; Implication for assets with risk; Digression junk bonds and bankruptcy;
Application: QE2 and the unwinding of the Fed Position.
Reading: JW3
10-21
Class 7 : Risk
Each
Security has uncertain payoffs; Down side VS Upside; Risk aversion: Expected
utility and utility of expected value; Basic mean variance trade off in
utility; Individual heterogeneity and sorting in markets.
Reading: JW6
10-23
Class 8: The Portfolio approach to risk
More
than one security out there and returns not perfectly correlated; Portfolios
have better mean return profiles than individual stocks; Efficient frontier and
the Sharpe value; Basic portfolio separation;
Why not insurance contracts?
Reading: JW7
An Early Paper: Harry Markowitz, Portfolio Selection The Journal of Finance, Vol. 7, No. 1 (Mar., 1952), pp. 77-91
10-28
Class 9: The portfolio approach and the Price of securities
CAPM; Rise of the passive investor; What happens when new information comes in; Another no trade
result?
Reading: JW8;
An Early Paper: William F. Sharpe, Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk The Journal of Finance, Vol. 19, No. 3 (Sep., 1964), pp. 425-442
10-30
Class 10: Market efficiency
Alpha and Beta; Problems with CAPM
Reading: JW9;
Eugene Fama and Kenneth R French; The Value Premium and the CAPM; The Journal of Finance, Vol. 61, No. 5 (Oct., 2006), pp. 2163-2185
10-30
–11-4 Midterm rules
Instructions: This exam is open book and notes, but it
should involve your work only, you will need a calculator and can use a
computer. For each question where a
computation is needed your answer must consist of the derivation of the
formulas you need to arrive at your answer and the actual numerical solution,
two digit precision is good (on interest rates, that is in 100th of
percents). This exam should take you about an hour and half but you may use as
much as three hours. To get full credit you must complete this exam by Nov 4
start of class. You can turn it in to my
box or to the box outside my office.
The
exam will be posted after class on Wednesday October 30.
MIDTERM EXAM
Download the file only when you are ready to take it.
11-04
Class 11: Intermediaries and assets
Definition; creating new assets:
Transformation; Bundling; Unbundling; taking positions Leverage
Reading: Arnold
Chapters 2-5
11-06
Class 12 Forwards and Futures
Financial markets as
insurance markets; Instruments and exchanges; The
counterparty risk problem
Reading: JW10 Arnold Chapters 14 and 15.
Visit Chicago Merchantile exchange website
11-11
Class 13 Options and Hedging
Why Hedge; Why options; Pricing options, the
one period problem;
Reading: JW11;
Arnold Chapter 17.
Original Paper: Black, F. and Scholes, M. The Pricing of Options and Corporate Liabilities Journal of Political Economy, Vol. 81, No. 3 (May - Jun., 1973), pp. 637-654\
11-13
Class 14 Option prices,
The multi-period problem; The Black-Sholes
equation and formula
Reading: JW11;
Arnold Chapter 17.
11-18
Class 15 Risk
and the firm (one project)
Firms as projects; information revelation; then
Financial governance as corporate governance: Debt vs equity; the bankruptcy constraint; Sunk costs.
Reread
JW5 and
Tirole,
Jean: Corporate Governance Econometrica,
Vol. 69, No. 1 (Jan., 2001), pp. 1-35
11-20
Class 16 Firms as portfolio of projects
Debt equity and retained earnings; implications
for governance. Project selection again. Should firms’ hedge?
Reading BO3
11-25
Class 17, The problem of Mortgages
Lending on collateral before 1940 (land and
real property); Information constraint (value of collateral only known
locally); Short maturity, balloon payment, illiquid and poorly diversified
Solutions (1): Raise the information quality
(lien registries); Financial innovation (covered
mortgages)
Solution (2): Mortgage backed securities and no
leverage rules; Boom and bust
Debate: role of government here.
Juan Carlos Hatchondo,
Leonardo Martinez and Juan M. Sánchez “Europe May
Provide Lessons on Preventing Mortgage Defaults”. The Regional Economist July 2013
Elena Loutskina
and Philip E. Strahan “ informed
and uninformed investment in housing; the downside of diversification; forthcoming Review of Financial
Studies.
11-27
Class 18 Government and financial structure
Regulated vs
unregulated financial actors; Banks vs the shadow banking
sector; Commercial banks vs investment banks; Aided vs unaided financial actors; Consequences for firms; Consequences for investors.Bail outs vs No bail
outs
Reading Ragu Rajan “Has Financial Development Made the World Riskier?” European
Financial Management, September 2006, 12(4), pp. 499-533.
Ross Levine, ““The Governance of Financial Regulation: Reform Lessons from the Recent Crisis” International Review of Finance, forthcoming.
12-02
Class 19 Liquidity Crises
History:
1907 and the founding of the FED; LTCM vs Barings
(1890s and 1990s); 2008 (AIG, some banks) rationale for deployment of TARP;
Deleveraging vs Reform.
Reading:
Arnold Chapter 17-18. And one of the two below.
Frederic
S. Mishkin, “Over the Cliff: From the Subprime to the
Global Financial Crisis” (pp. 49-70) Journal
of Economic Perspectives: Vol. 25 No. 1 (Winter 2011)
Vincent
Reinhart “A Year of Living Dangerously: The Management of the Financial Crisis
in 2008” (pp. 71-90) Journal of Economic
Perspectives: Vol. 25 No. 1 (Winter 2011)
12-04
Class 20 Long Term Crashes
Structure and reform
12-10
Final exam due no later that December 12 5 pm in my
mailbox
Homework and exam calendar
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Item |
Posted |
Due |
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Financial portfolio 1 |
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Oct 4 9 AM |
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Sept 30 |
Oct 7 5 PM |
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Financial portfolio 2 |
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Oct 11 |
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October 6 |
Due 14 |
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Financial portfolio 3 |
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Oct 18 |
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QUIZ 1 |
Oct 09 |
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October 13 |
Due 21 |
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Financial portfolio 4 |
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Oct 25 |
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QUIZ 2 |
Oct 16 |
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QUIZ 3 |
Oct 21 |
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Due 28 |
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QUIZ 4 |
Oct 24 |
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Oct 30 |
Nov 4
Answer key |
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Financial portfolio 5 |
Oct30 |
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QUIZ 5 |
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Oct30 |
Nov 8 |
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Financial portfolio 6 |
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Nov 8 |
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Nov 3 |
Nov 11 |
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QUIZ 6 |
Nov 4 |
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QUIZ 7 |
Nov 11 |
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QUIZ 8 |
Nov 13 |
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Financial portfolio 7 |
Nov 15 |
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Nov11 |
Nov 18 |
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QUIZ 9 |
Nov 20 |
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Financial portfolio 8 |
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Nov 22 |
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QUIZ 10 |
Nov 25 |
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Nov 25 |
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QUIZ 11 |
Nov 27 |
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Financial portfolio 9 |
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Nov 27 |
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QUIZ 12 |
Dec 2 |
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Dec 2 |
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Financial Portfolio liquidation |
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Dec 5 |
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Dec 10 |
Dec 12 5pm |
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Bem 103 Financial journals J-L
Rosenthal
Overview:
As part of BEM 103 students are expected to keep a financial journal and turn
it by Email in 10 times in the quarter. The
data have no research value and the instructor will not use the data for
research purposes. The purpose of the journal is to engage students with real
financial decisions and have them investigate different classes of assets and
different ways of dealing with financial markets. The journals, once turned in will allow the
instructor to produce a data base of student choices that will be use solely
for expositional purposes. For instance,
it is likely that students will be more engaged in discussion of yield curves
and risk return trade-offs if they see a distribution of portfolio decisions
they and their peers made than if the instructors just simply displays the
current yield curve. Discussions of
attitudes towards risk are likely to be sharper if they are accompanied with
distribution of leverage choices (week 5 and 6).
Description
for students (Finance
Journal-Instructions for students)
You
will be making 9 investment decisions (one per week through week 9) each will
have a fictitious $10,000 attached. By the end of the week 9 you will have thus
invested a fictitious $90,000. At the
end of week 10 you will liquidate your portfolio and total up your gains or
losses.
Each
week you will make an investment decision and evaluate the performance of the
decisions you made in previous weeks and compare them to relevant benchmarks.
Regular credit: You will earn regular course
credit for turning in your journals on time. Journals are due Friday in section, they can
be turned earlier in the week but not later a journal that is turned in late
automatically forfeits that week’s credit. Each week the work is turned in
completed you will earn 3pts (out of a total of 150 for the course). Late journals cannot be accepted because they
would have an informational advantage over those turned in on time.
Extra credit: How well you do does not influence your grade. Instead, journals will be ranked in terms of final performance by decile your extra credit will simply the decile of your performance relative to your peers. Only those investment decisions made on time (before Friday 9 am of the relevant week) will count in your earnings. We will also use the distribution of portfolio choices for discussion in class but the individual data will remain confidential.
Open an excel spread Sheet use the first sheet for the first week. Please use your initials followed by a three digit number (e.g. JLR801) to identify your spread sheet.
Financial Journal Week 1
Decision 1: On sheet 1. you have $10,000 to invest in a bond what would you chose among those that are quoted on US exchanges. Give details of the bond: name, maturity, coupon, current face value, yield and anything else you found out about it. And Current price! Why did you pick it?
Email to your TA by October 4 9 am
Financial Journal Week 2
Update
Return
to sheet 1. Keep the data you had before and Update data so that you have price
and check if coupon payment was made. What is your one week return? What is the
variance using daily close as observations?
Decision 2.
On sheet 2 of your excel spread sheet .You have $10,000 to invest in a stock what would you chose among those that are quoted on US exchanges. Give details of the stock: name, anything else you found out about it, And current price! Why did you pick it?
Email to your TA by deadline
Financial Journal Week 3
Update
Return
to sheet 1. Update price and check if coupon payment was made. What is your two
week return? What is it weekly? What is
the variance using daily close as observations? Is the same if you use week 2
observations or week 2 and 1?
Return
to sheet 2. Update price and check if dividend payment was made. What is your
one week return? What is the variance
using daily close as observations?
Decision 3.
On sheet 3 of your excel spread sheet: You have $10,000 to invest in up to 10 stocks that are quoted on US exchanges. How much do you invest in each stock? Give details of the bond: name, anything else you found out about it, And Current price!
Email to your TA by deadline
Financial Journal Week 4
Update
Return
to sheet 1. Update price and check if coupon payment was made. What is your two
week return? What is it weekly? What is
the variance using daily close as observations? Is the same if you use week 2
observations or week 2 and 1?
Return
to sheet 2. Update price and check if dividend payment was made. What is your
one week return? What is the variance
using daily close as observations?
Return
to sheet 3. Update prices for each security and check if dividend payments were
made. What is your one week return? What
is the variance using daily close as observations?
Decision 4.
On sheet 4 of your excel spread sheet: You have $10,000 to invest in up to 10 stocks that are quoted on US exchanges. But now you can go short (have negative weights on some of these securities as long as your total weighted investment sums to $10000)
Do you short some stocks? How much do you invest in each stock? Give details of the bond: name, anything else you found out about it, And current price!
Email to your TA by deadline
Financial Journal Week 5
Update
Return
to sheet 1. Update price and check if coupon payment was made. What is your two
week return? What is it weekly? What is
the variance using daily close as observations? Is the same if you use week 2
observations or week 2 and 1?
Return
to sheet 2. Update price and check if dividend payment was made. What is your
one week return? What is the variance
using daily close as observations?
Return
to sheet 3. Update prices for each security and check if dividend payments were
made. What is your one week return? What
is the variance using daily close as observations?
Return
to sheet 4. Update prices for each security and check if dividend payments were
made. What is your one week return? What
is the variance using daily close as observations?
Decision 5.
On sheet 5 of your excel spread sheet: You have $10,000 to invest in stocks that are quoted on US exchanges. But now you are charged $100 per stock that you buy and a 1% charge on your investment. You cannot go short.
How many stocks do you purchase? How much do you invest in each stock? Give details of the bond: name, anything else you found out about it, and current price!
Email to your TA by deadline
Financial Journal Week 6
Update
Return
to sheet 1. Update price and check if coupon payment was made. What is your two
week return? What is it weekly? What is
the variance using daily close as observations? Is the same if you use week 2
observations or week 2 and 1?
Return
to sheet 2. Update price and check if dividend payment was made. What is your
one week return? What is the variance
using daily close as observations?
Return
to sheet 3-5. Update prices for each security and check if dividend payments
were made. What is your one week return?
What is the variance using daily close as observations?
Decision 6.
On sheet 6 of your excel spread sheet: You have $10,000 to invest in 10 stocks that are quoted on US exchanges and you can borrow up to $40,000 at an interest rate of 0.05% per week. You cannot go short. If at the end of any week your investment fund is worth less than you have borrowed you will be required to liquidate and you will not be able to borrow henceforth. How much money do you borrow? How many stocks do you purchase? How much do you invest in each stock? Give details of the bond: name, anything else you found out about it, and current price!
Email to your TA by deadline
Financial Journal Week 7
Update
Return
to sheet 1. Update price and check if coupon payment was made. What is your two
week return? What is it weekly? What is
the variance using daily close as observations? Is the same if you use week 2
observations or week 2 and 1?
Return
to sheet 2. Update price and check if dividend payment was made. What is your
one week return? What is the variance
using daily close as observations?
Return
to sheet 3-5. Update prices for each security and check if dividend payments
were made. What is your one week return?
What is the variance using daily close as observations?
Return
to sheet 6. Update portfolio value and check that you are solvent (fund value
is greater than the amount you borrowed and accumulated interest). What is your one week return? What is the variance using daily close as
observations?
Decision 7.
On sheet 7 of your excel spread sheet: You have $10,000 to invest in 10 stocks that are quoted on US exchanges and you can borrow up to $40,000 at an interest rate of 0.2% per month. You cannot go short. If at the end of any week your investment fund is worth less than you have borrowed you will be required to reimburse the loan from funds in investments 1-6. How much money do you borrow? How many stocks do you purchase? How much do you invest in each stock? Give details of the bond: name, anything else you found out about it, and current price!
Financial Journal Week 8
Update
Return
to sheet 1. Update price and check if coupon payment was made. What is your two
week return? What is it weekly? What is
the variance using daily close as observations? Is the same if you use week 2
observations or week 2 and 1?
Return
to sheet 2. Update price and check if dividend payment was made. What is your
one week return? What is the variance
using daily close as observations?
Return
to sheet 3, 4, 5,6,7. Update prices for each security
and check if dividend payments were made. What is your one week return? What is the variance using daily close as
observations?
Return
to sheet 6. Update portfolio value and check that you are solvent (fund value
is greater than the amount you borrowed and accumulated interest). What is your one week return? What is the variance using daily close as
observations?
Decision 8.
On sheet 8 of your excel spread sheet: You have $10,000 to invest in up to three commodity futures quoted on a US exchange. What do you choose and how much do you purchase, remember you will be forced to liquidate if your collateral account dips bellow the minimum value.
Financial Journal Week 9
Update
Return
to sheet 1. Update price and check if coupon payment was made. What is your two
week return? What is it weekly? What is
the variance using daily close as observations? Is the same if you use week 2
observations or week 2 and 1?
Return
to sheet 2-8. Update prices for each security and check if dividend payments
were made. What is your one week return?
What is the variance using daily close as observations?
You
have 10,000 to invest in something that will liquidate next week. Surprise your teacher.
Financial Journal Week 10
Liquidate
your position on sheet 10 (at Thursday December 5 closing prices)
1)
For
each week, what was the value of the position you opened. What is its value
(Thursday December 5 at 5pm) what is you profit or loss? This should be a number of dollars. Be sure
to factor in coupon payments and dividends.
2)
Remember
if you went short on a stock your profit is the early price – late price (you
make money if prices have fallen).
3)
For
week 5 either you took the fees at the beginning, or you must pay them on exit.
4)
For
week 6 you must first pay off your loans and interest. Then if you made a loss for week 6 enter 0 as
final return (you had limited liability)
5)
For
week 6 you must first pay off your loans and interest and then carry the loss.
6)
Total
up all your 9 different investment returns and that is what you made or lost.